By Joe Leahy in Mumbai
March 19, 2010
India’s central bank on Friday announced a surprise 25-basis point increase in its key policy rates – the first rise in nearly two years – in a bid to head off inflation that is poised to cross into double digits.
In an unscheduled move, the Reserve Bank of India increased the “reverse repo rate”, the rate at which it absorbs money from the system, by 25 basis points to 3.5 per cent and the “repo rate”, the rate at which it lends to banks, by the same margin to 5 per cent.
The rises, which come a month ahead of the RBI’s next quarterly policy meeting, mark the beginning of what economists expect to be a long tightening cycle as regulators seek to foster India’s economic recovery while capping politically sensitive inflation.
“The timing is a surprise but the way inflation is behaving at the moment, they don’t have much choice,” said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.
For India’s ruling Congress party-led coalition, keeping a lid on inflation is seen as the number one political priority in a nation where governments have risen and fallen on the price of staple foods, such as onions.
India’s economy is expected to return to growth rates of more than 8 per cent this year as the country emerges from the economic crisis with its record as the world’s fastest growing large economy behind China intact.
But an expansionary government budget, growing domestic consumption and rising energy prices are driving up inflation, with the wholesale price index, the main measure of inflation in India, reaching 9.89 per cent year-on-year in February compared with 8.56 per cent a month earlier.
The February figure was the highest since October 2008 and above the central bank’s end-Marchforecast of 8.5 per cent.
“While the recovery in growth has proceeded broadly along expected lines, the inflationary pressures have intensified beyond our baseline projection,” the RBI said in a statement last night.
“With rising demand side pressures, there is risk that WPI inflation may cross double digits in March 2010.”
It said there was a need not only to contain inflation but to also send a signal to the market that regulators would not tolerate the inflationary trend.
While food prices were moderating, they remained “elevated”, and the rate of price increases among non-food manufactured goods was accelerating "quite sharply".
The move follows the RBI’s announcement in January of a 75 basis point rise in the cash reserve ratio, the proportion of deposits banks must keep with the central bank, to 5.75 per cent, to soak up excess liquidity.
ICICI Securities’ Mr Prasanna said he expected a further 25bp tightening at the next policy meeting.
“It’s going to be a long road ahead,” he said.